You’re feeling great because you have your tax information ready for your CPA, and then your accountant takes one look at your 1099 from your brokerage account and asks what your cost basis was in the stocks you sold. What? You made money on your investments. You know you’ll be paying capital gains—15%, right? Yes, but on how much?
Cost basis is the original value you paid for your asset, be it a house, a stock, a piece of farm equipment, etc. If you sell your asset for more than you paid, you made a gain—sell price minus the original price.
With stocks, mutual funds, and the like, cost basis can get a little more complicated, as it is often adjusted for stock splits, dividends, reinvestments, and return of capital distributions. If you’ve reinvested the distributions, you likely increased your cost basis, thus lowering your gain, resulting in fewer taxes owed.
Most often, we look at an average cost basis. Take the example of dollar-cost averaging, where you invest $100 each month, buying different amounts of shares based on the market price for the stock. We take the total amount invested; divide it by the total number of shares purchased, to arrive at the average price paid per stock. That is your average cost basis.
However, during your dollar-cost averaging, the price for ABC stock was at its all-time high at $50, and for your monthly $100, you only received two shares of stock. At the end of the year, you see that ABC stock is selling for $20 a share. If you sell shares from a specific tax lot, you could claim a loss on those two shares you paid $50 each for yet still have an overall gain in the position. Keeping track of your cost basis per individual lot allows you to control your overall tax situation.
How you acquired the asset also affects the cost basis. If you are gifted the asset, you inherit the cost basis of the original holder. If your mom transfers $10,000 of stock into your name, you need to know the cost basis before you sell. If she only paid $2,000 for it and held it until the market price grew to $10,000, your mom just transferred $8,000 in gain to you. If you sell it, you’ll owe taxes on the proceeds. However, your mom passes away and you inherit $10,000 in stock, your cost basis is the market value of the stock the day she died. This is a step-up in basis, which may allow you to sell with minimal capital gain.
Generally, your custodian will report cost basis, but the requirement to do so only began in 2011 with certain types of investments. For any transactions before 2011, it’s up to the investor to track and report cost basis. If you don’t know the original purchase price of a stock, you can generally look up historical prices online for the time when you initially purchased it. Cost basis can become complicated very easily, so it is always wise to work with a C.P.A. or financial adviser for significant transactions.
If you have questions on determining the cost basis of your investments, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
Listen to the February 5, 2022 “Henssler Money Talks” episode.
This article is for demonstrative and academic purposes and is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
